The banks are fine but the rest of us will take a hit this year as the economy is expected to go into recession in the wake of the U.S. banking crisis, according to minutes from the March meeting of the Federal Open Market Committee (FOMC) — the branch of the Federal Reserve that determines the direction of monetary policy.
“Historical recessions related to financial market problems tend to be more severe and persistent than average recessions,” according to the Fed meeting minutes.
Following the banking meltdown triggered by a run on Silicon Valley Bank in early March, the U.S. banking system remains “sound and resilient,” said Michael Barr, vice chairman of supervision of the Board of Governors of the Federal Reserve.
However, Fed staff economists predict a recession, saying recent developments in the banking sector will likely make it harder for households and businesses to borrow money and would “weigh on economic activity, hiring, and inflation.”
President Joe Biden and Treasury Secretary Janet Yellen have been accused of downplaying recession fears.
Meeting participants said that since their previous meeting in February, data on inflation, employment, and economic activity have come in stronger than expected. However, developments in the banking sector in early March affected their views of the economic and policy outlook.
“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years,” the meeting summary said.
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During the pandemic, SVB and many other banks raked in more deposits than they could lend out to borrowers. Deposits at SVB doubled in 2021. What the banks could not lend out, they invested in ultra-safe U.S. Treasury securities. A rapid increase in interest rates in 2022 and 2023 caused the value of these securities to fall. SVB said it took a $1.8 billion hit on the sale of some securities and was unable to raise capital to offset the loss as its stock began plunging. Prompted prominent venture capital firms advised the companies they invest in to pull their business from SVB. This produced a snowball effect as other SVB depositors also withdrew their money. The investment losses and withdrawals were so large that regulators had no choice but to step in to shut the bank down to protect depositors, according to a PBS analysis.
The banking crisis has raised expectations that the central bank will ease up on rate hikes to reduce banking stress. Some investors are betting on it. Jeffrey “Bond Market King” Gundlach previously made a case for bonds, saying “investors should look at what the market says over what the Fed says” when it comes to trying to figure out what interest rates will do.
However, the Fed has given no indication that it intends to slow down rate hikes. On the contrary, the market is getting it wrong by predicting rate cuts this year, Federal Reserve Chairman Jerome Powell said in March after announcing a new interest rate hike of 0.25 percent.
The ninth rate hike in a year and the first after two weeks of banking turmoil brought the benchmark funds rate to a range of 4.75-to-5 percent.
SVB was the biggest U.S. lender to fail since the 2008 global financial crisis and the second-biggest ever.
Fed officials said at the meeting that they see prices going down and inflation slowing “sharply.”
“Reflecting the effects of less projected tightness in product and labor markets, core inflation was forecast to slow sharply next year,” the minutes said. But concern remains high over broader economic conditions, especially in light of the banking crisis.
Emergency programs helped get the banking industry through the immediate crisis, but officials said they expect lending to tighten and credit conditions to deteriorate.
“Even with the actions, participants recognized that there was significant uncertainty as to how those conditions would evolve,” the minutes said.